Transcript Part and/or Chapter Number and Title

Chapter 14:
Aggregate Demand and
Aggregate Supply
McGraw-Hill/Irwin
Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved
Aggregate Demand –
Aggregate Supply Model
 The AD-AS model enables us to analyze changes
in real GDP and price level simultaneously.
 The AD-AS model provides keen insights on
inflation, recession, unemployment, and economic
growth.
Aggregate Demand – Aggregate Supply (AD-AS) model
is the macroeconomic model that uses aggregate demand
and aggregate supply to determine and explain the price
level and level of real domestic output.
LO: 14-1
14-2
 Aggregate demand curve
is a schedule that shows the
total quantity of goods and
services demanded at
difference price levels.
 There is an inverse
relationship between the
price level (as measured by
the GDP price index) and
real output demanded (real
GDP).
Price Level
Aggregate Demand and
Aggregate Demand Curve
Aggregate
Demand
AD
Real Domestic Output, GDP
LO: 14-1
14-3
Changes in Aggregate
Demand
Determinant:
Factor(s) of Determinant:
AD shifts:
Consumer
Spending
Consumer wealth increases
Consumers’ real incomes rise
Household indebtedness rises
Tax increases
Investment
Spending
Increases in real interest rate
Higher expected returns
LEFT
RIGHT
Government
Spending
Increase in government spending
RIGHT
Net export
Spending
Rising national income abroad
Depreciation of the dollar
RIGHT
RIGHT
LEFT
LO: 14-1
14-4
Shifts in Aggregate
Demand Curve
Price Level
Increase in
Aggregate
Demand
Decrease in
Aggregate
Demand
AD2
AD1
AD3
LO: 14-1
Real Domestic Output, GDP
14-5
Aggregate Supply
 Aggregate supply curve is a schedule that shows the
total quantity of goods and services supplied at difference
price levels.
 The aggregate supply curve in the short run and in the
long run vary by degrees of wage adjustment
 In the immediate short run, output and input prices are
fixed, and the AS curve is horizontal
 In the short run, output prices are flexible while input prices
are sticky, thus the AS curve is positively sloped
 In the long run, all prices are flexible, economy is at the full
employment (output is equal to potential), the AS curve is
vertical
LO: 14-2
14-6
Price Level
Immediate Short Run
Aggregate Supply
ASISR
Immediate Short Run
Aggregate Supply
LO: 14-2
Real Domestic Output, GDP
14-7
Short Run
Aggregate Supply
Price Level
Aggregate Supply
(Short Run)
0
Qf
Real Domestic Output, GDP
LO: 14-2
14-8
Long Run
Aggregate Supply
Price Level
ASLR
Long Run
Aggregate
Supply
LO: 14-2
Real Domestic Output, GDP
14-9
Changes in Aggregate
Supply
Determinant:
Input Prices
Factor(s) of Determinant:
Domestic resource prices rise
Prices of imported resources rise
AS shifts:
LEFT
Increased market power
Productivity
Increases in productivity
LegalInstitutional
Environment
Higher business taxes
More government regulation
RIGHT
LEFT
LO: 14-2
14-10
Shifts in Aggregate
Supply Curve
AS3
AS1
Decrease in
Aggregate
Supply
Price Level
AS2
Increase in
Aggregate
Supply
LO: 14-2
Real Domestic Output, GDP
14-11
Equilibrium Price Level
and Real GDP
 Equilibrium occurs at the price level that
equalizes the amount of real output
demanded and supplied.
 Equilibrium point is the intersection of the
aggregate demand curve and aggregate
supply curve.
 This intersection determines the equilibrium
price level and equilibrium real output.
LO: 14-3
14-12
Equilibrium
Real Output
Demanded
(Billions)
LO: 14-3
Price Level
(Index Number)
Real Output
Supplied
(Billions)
$506
108
$513
508
104
512
510
100
510
512
96
507
514
92
502
Equilibrium Price Level and
Equilibrium Real GDP
14-13
Equilibrium
Price Level
AS
Equilibrium
100
AD
LO: 14-3
510
Real Domestic Output, GDP (Billions of Dollars)
14-14
Using AD-AS Model to Explain
Inflation and Recession
 When aggregate supply and aggregate demand change,
inflation and recession can occur in the short run.
 Demand-pull inflation occurs when aggregate demand
increases (AD curve shifts to the right).
 Cost-push inflation occurs when costs of production
rise (AS curve shifts to the left).
 Recession occurs when aggregate demand falls (AD
curve shifts to the left) and prices are sticky downwards.
LO: 14-4
14-15
Demand-Pull Inflation
Increase in Aggregate Demand
Price Level
AS
Demand-Pull
Inflation
P2
P1
AD1
AD
LO: 14-4
Qf
Q1
Real Domestic Output, GDP
14-16
Cost-Push Inflation
Decrease in Aggregate Supply
Price Level
AS1
Cost-Push
Inflation
P2
P1
AS
b
a
AD
LO: 14-4
Q1 Qf
Real Domestic Output, GDP
14-17
Recession
Decrease in Aggregate Demand
Price Level
AS
b
P1
a
Creates a
Recession
AD1
AD2
LO: 14-4
Q2
Qf
Real Domestic Output, GDP
14-18